Publications

Working Paper No. 489
| January 2007

Fixed and Flexible Exchange Rates and Currency Sovereignty

This paper provides an analysis of Keynes's original "Bancor" proposal as well as
more recent proposals for fixed exchange rates. We argue that these schemes fail to
pay due attention to the importance of capital movements in today's economy, and
that they implicitly adopt an unsatisfactory notion of money as a mere medium of
exchange. We develop an alternative approach to money based on the notion of
currency sovereignty. As currency sovereignty implies the ability of a country to
implement monetary and fiscal policies independently, we argue that it is necessarily
contingent on a country's adoption of floating exchange rates. As illustrations of the
problems created for domestic policy by the adoption of fixed exchange rates, we
briefly look at the recent Argentinean and European experiences. We take these as
telling examples of the high costs of giving up sovereignty (Argentina and the
European countries of the EMU) and the benefits of regaining it (Argentina). A
regime of more flexible exchange rates would have likely produced a more viable and
dynamic European economic system, one in which each individual country could
have adopted and implemented a mix of fiscal and monetary policies more suitable to
its specific economic, social, and political context. Alternatively, the euro area will
have to create a fiscal authority on par with that of the US Treasury, which means
surrendering national authority to a central government—an unlikely possibility in
today's political climate. We conclude by pointing out some of the advantages of
floating exchange rates, but also stress that such a regime should not be regarded as a
sort of panacea. It is a necessary condition if a country is to retain its sovereignty and
the power to implement autonomous economic policies, but it is not a sufficient
condition for guaranteeing that such policies actually be aimed at providing higher
levels of employment and welfare.